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Colombia surprising tightening

May 6, 2014

In April, monetary policy decisions were made in 20 of the countries we cover

In April, monetary policy decisions were made in 20 of the countries we cover, four of which changed their monetary rates. The major surprise was the 0.25-pp increase in Colombia, a country where, unlike in most of the emerging-market economies, economic activity continues to expand briskly. The rate increase was preventive, as inflation is low and the Colombian peso was already appreciating in response to higher foreign interest in Colombian fixed-income securities in local currency. Thus, the central bank of Colombia is now accumulating reserves at a faster pace than before.

Interest rate movements in other countries – rate increases in Brazil and New Zealand, a rate cut in Hungary – continued cycles started in the past and were in line with market expectations. Another highlight of the month was Chile’s decision to interrupt, if only momentarily, its easing cycle. The central bank maintained the downward bias, but the decision shows that the central bank is getting a little more concerned about the potential secondary effects of the exchange-rate depreciation.

Among the G3 countries, the Fed continued to reduce its monthly securities purchase volume, while the European Central Bank kept its monetary rates unchanged earlier this month but signaled a more expansionary stance in its official communication.

1. Policy rates: Historical table

2. Charts

3. Monetary policy in LatAm

Brazil: Copom: End of the cycle, even with inflation still under pressure

The Brazilian central bank’s monetary policy committee (Copom) decided in early April to raise the Selic rateby 25 bps, to 11.00%, as widely expected.

Importantly, the Copomchanged the post-meeting statement to signal the end of the tightening cycle. Compared with the previous statement, the committee removed the expression “continuing the adjustment process” from the last statement and added “at this moment.” Both moves signal, in our view, the intention to end the tightening cycle briefly. The statement also added that the “committee will monitor the evolution of the macroeconomic scenario until its next meeting, to then decide the next steps on its monetary policy strategy.” Based on past Copom communications, we take this as a sign that the end of the cycle is near.

Inflation still under pressure does not seem to change Copom’s strategy. IPCA inflation remains at an elevated level, pressured by food government-managed prices. Even though, the Committee seems confident that inflation will remain under control. In the minutes of its April meeting, the Copom reminded that “as the effects of monetary policy actions on inflation are cumulative and materialize with lags, the committee understands that a significant part of the response of prices to the current monetary tightening cycle has yet to materialize.” The minutes also highlight the recent increase in food prices, but qualify it as localized and, at first, temporary.

We maintain our call for the Selic this year and increased our forecast for 2015. In our view, the statement and the minutes of the last Copom meeting are consistent with our scenario, in which the Copom will maintain the Selic rate at its current 11.00% level until the end of 2014. For 2015, inertia caused by higher inflation this year and the need for an adjustment in regulated prices may require greater effort in monetary policy to keep inflation stable. Our estimate for the Selic rate at 12.50% by the end of next year.

Chile: Only a Pause in the Easing Cycle

As expected, Chile’s central bank left the policy rate unchanged at 4.0% in April. The decision to hold the rate follows two 25-bp rate cuts over the past two months. Importantly, the central bank kept the easing bias, with the exact same wording as in the previous decision: “the board will evaluate the possibility of introducing additional policy rate cuts, according to the evolution of internal and external macroeconomic variables and their implication for the inflation outlook”.

In our view, the decision to hold the interest rate is just a pause in the easing cycle. The evolution of the output gap leaves enough space for the central bank to introduce further monetary stimulus. Recently, board member Pablo Garcia gave a speech where he said that there is no a dilemma for the central bank (alluding to the mix of higher inflation and below trend growth), arguing that the recent increase in CPI was due to temporary factors. He mentioned that the main drivers of inflation in the long term are both the inflation expectations and the output gap.

We expect the central bank to resume the easing cycle in May. Nevertheless, we acknowledge that the board might want to wait slightly longer before reducing the policy rate again. In our scenario, the easing cycle is finalized before the end of 3Q13 with a policy rate of 3.5%. We see the beginning of a tightening cycle in late 2015, but only if the economy gives solid signals that the recovery is underway.

Colombia: An Earlier Than Expected Start To The Tightening Cycle

Colombia's central bank raised the policy rate by 25 bps, surprising our expectation and market consensus. According to the press statement announcing the decision, the ongoing convergence of inflation towards the target center is consistent with a less expansionary monetary policy than the current one.

Furthermore, the board considers that a gradual increase of the monetary policy rate prevents the need for a sharper interest rate adjustment in the future. The decision also takes into account that monetary policy impacts activity and inflation with lags, according to the statement.

The central bank also noted that the Colombian asset prices recently outperformed its peers (especially, the public debt).

We now expect the policy rate to end this year at 4.25%, with another three non-consecutive 25-bp interest-rate hikes (in our previous scenario we expected a 3.75% rate by the end of this year). A tighter than expected monetary policy will certainly contribute to attracting more capital flows to Colombia, at a time when foreign participation in local market bonds is already increasing. We now expect the Colombian peso to end this year at 1950 to the dollar (from 2000 pesos to the dollar in our previous scenario).

Mexico: Rate and Bias Remain Unchanged

As widely expected, the central bank left the policy rate unchanged in its April monetary policy meeting. The tone of the press statement announcing the decision was similar to the previous one. In the concluding remarks, the board once again highlighted the evolution of the output gap as one of the factors that it will monitor in upcoming meetings. Still, the board continues to say that it will also monitor the monetary policy stance relative to the U.S. So in our view, a neutral bias remains.

The central bank sees unchanged balance of risks for inflation and marginally better balance of risks for activity. Board members stated that Mexico’s economy has grown below expectations in 1Q14, but they sounded more optimistic regarding activity ahead, due to the recent performance of some activity indicators. Regarding inflation, the board remains upbeat, noting that there were no second-round effects from the new taxes introduced in January, as inflation has continued to decline. The central bank also highlighted the lower non-core inflation, as a consequence of the fading supply shocks that affected food prices in previous months.

In our view, the statement reaffirms that the central bank is unlikely to change its policy rate soon. We don’t expect policy rate moves in Mexico this year. However, we expect a tightening cycle in 2015, once the Fed starts to raise rates.

Peru: Unchanged Reserve Requirement Rate in May

Once again, the central bank maintained the interest rate (at 4.0%) in its April monetary policy meeting. As in previous meetings, the press release mentioned that this decision is consistent with the convergence of inflation to the 2.0% target within the 2014 – 2015 horizon. Furthermore, Governor Julio Velarde stated that the reserve requirement rate would be left unchanged this month, after five consecutive monthly reductions.

We still expect the central bank to leave the interest rate unchanged throughout our forecast horizon, and we also see limited space for further reductions in the reserve requirement rate. Credit in domestic currency is clearly reacting to the reserve requirement reductions, casting doubts over the need of further easing through quantitative measures.